US regulators target risky commercial real estate loans

Just days after the US Federal Reserve decided to increase US base rates from 0% up to 0.25% it was revealed that US regulators will be targeting real estate loans next year. In a veiled warning the authorities have commented upon the massive increase in real estate based loans across the US banking sector. This is perfectly illustrated by news that $1.769 trillion of commercial real estate loans were outstanding as of the week ending 2nd December 2016. However, there is more to the story.

Small banks

While the $1.769 trillion of commercial real estate loans outstanding to the US banking community is enormous, it was revealed that around $1.1 trillion is attributed to what are described as “small banks”. This would seem to suggest there is a growing trend across the US banking sector to fund the ever-growing real estate industry. While the close relationship between banks and real estate companies goes back many years, it is the fact that so much of the outstanding debt is attributed to “small banks” which is causing most concern.

Are we moving towards a 2008 scenario?

While some investors have very short memories when it comes to financial difficulties many of us can remember in great detail the 2007/8 financial crisis which brought the worldwide economy to its knees. The catalyst for this collapse in worldwide economic activity was the US mortgage industry with particular emphasis on those choosing to deal with more risky clients.

It was the so-called “small banks” which struggled in the aftermath of the mortgage crisis with many of them going to the wall. This led to a lack of confidence, a liquidity crisis and only now have we seen the US Federal Reserve increase base rates for the first time since the crash. Even then, a rise of 0.25% from the previous level of 0% is a move in the right direction but a minuscule move in the overall picture.

Are regulators right to issue a warning?

In many ways the comments attributed to US regulators this week are shot across the bows of the financial sector and the real estate industry. You could argue this is simply a case of “Big Brother is watching” but there is certainly more to this behind the scenes. The increase in US base rates this week will obviously make finance more expensive but the authorities seem determined to ensure there will be no major shocks in the short to medium term.

It also seems highly likely will see a raft of new regulations next year aimed at “risky lending” and indeed many banks may be forced to raise more capital to increase their buffer against any short to medium term turbulence. Quite how the smaller banks will respond to this remains to be seen, but the US authorities seem to mean business and are determined to avoid a repetition of the 2007/8 sub-prime mortgage debacle which brought the world to its knees.

Will this trend be picked up by other regulators around the world?

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